The inventory cost is the cost associated with holding goods in stock. It is usually expressed as a percentage of the inventory value. This cost is worked out by the management to determine how much inventory to keep in hand. It includes the following categories of costs: ordering costs (cost associated with the ordering of goods), holding costs (cost associated with the holding of goods), and administrative costs.
Also called set up costs, these costs include the wages and salaries of the procurement staff, related benefits, overtime (if any), taxes and other expenses. If a new supplier needs to be pre-qualified before they can deliver goods to the company, the costs may include the labour costs of the industrial’s engineering staff who are tasked with doing the job. Ordering costs are typically included in a pool of overhead costs and allocated to the number of units handled in each period.
These are the costs of acquiring, storing and disposing of inventory. They include the costs of space (to hold the inventory), cost of money (to acquire the inventory), and the cost of obsolescence (to dispose damaged or unused goods). Holding costs form the bulk of inventory costs.
Costs of space
These are the costs related to the warehouse and includes the costs of maintenance, storage racks, utilities, inventory handling equipment, insurance, depreciation and warehouse staff. All buildings depreciate in value over time; hence the depreciation. Insurance is very important for protecting the inventory from theft and loss due to natural and manmade disasters. Costs of space may also include the costs of security devices, such as burglar alarms and fire suppression systems. The costs of space represent the largest inventory cost.
Cost of money
This is the interest to be paid to the creditor(s) on the funds used to pay for the inventory. Most companies use some loan to acquire inventory. If a company has not taken any loan, then this cost represents the interest income associated with the funds allocated for the acquisition of the inventory.
Cost of obsolescence
There are always chances that some inventory items will be damaged while being held in storage or will never be used. These items must be disposed of, usually at a reduced price or even at zero price. These are called obsolescence costs. If the inventory consists of perishable items, obsolescence costs can be quite substantial.
These costs include the wages and salaries of the cost accounting staff and non-operating staff. Cost accounting staff are the people who compiles the costs of inventory and the costs of goods sold, responds to requests for other inventory analysis, and defends their position to internal and external auditors. Administrative costs also include related general office expenses.
As you may have deduced, the cost of inventory can be substantial. This is why it is important to engage the best accounting services to monitor your business’s cost with due diligence. Failure to do so may result in losses as the costs can make a big dent in profits and cash reserves. If you are having problems with your inventory cost, seek the help of an experienced accounting firm to manage your finances today.